Newsweek is reporting that the Bank of England is exploring how to better predict how interest rates will rise and fall during the global financial crisis.
The research is part of a broader research project to understand how financial markets and markets are set up and to find ways of better forecasting the future, the publication reports.
According to the paper, a financial market “is not just a collection of individual financial instruments and instruments of interest, but also the interrelationships among them.”
The paper suggests that a model that incorporates the financial sector, such as an asset-backed bond or a mortgage-backed asset, will be able to provide a more accurate picture of the underlying structure of the financial system.
“We need to have a better understanding of how market behaviour changes during financial crises, and how it relates to what happens to interest rates in the future,” said John Foy, a professor of finance at the University of California, Irvine, who was not involved in the study.
“The best models that are out there can provide a better picture of how the financial markets operate in the years ahead,” he told Newsweek.
The paper’s authors are currently studying how the world’s markets operate, and the role that they play in the financial crisis, as well as what the Bank is trying to do to better forecast future events.
Foy told Newsweek that it is important to understand the financial models that work for us today and why they might not work for the future.
“If you look at all the models that we have, they’re all about how we manage our money,” he said.
“What they are not about is what the future holds.”
For example, the paper suggests a financial model that does not include the effects of climate change may be more accurate than one that does.
“There is a lot of uncertainty about the climate in the world right now, and we don’t really know the extent of it yet,” Foy said.
“So it is very hard to predict what will happen in the next few decades, and so these models may be better than the ones we have right now.”
But Foy noted that financial models do not necessarily provide a perfect forecast for the coming financial crisis and that models need to be constantly revised.
“What I like about this paper is that they are looking at this problem in the past and looking at what the models did then, and looking to see what changes are needed,” he added.
“This is really useful in the context of the future.”